Friday, June 02, 2006

What worries OPEC?

According to Forbes and just about every other business journal on the planet, OPEC decided on Thursday to keep oil production unchanged.

Call me crazy, but duh!

Global spare production capacity among all oil producing nations is now around 0.5 million barrels per day (mbpd). Before the Iraq War, spare capacity was around 6 mbpd. With no spare production capacity, OPEC has nowhere to go without inducing a catastrophic global supply crunch. (It is for this reason that many oil traders believe this is now a "supply" driven market, despite the fact that the steady, long-term increase in Chinese and Indian demand has been the principle reason excess production capacity has declined as much as it has.)

According to Forbes [emphasis mine]:
OPEC decided to keep pumping almost as much as it can, but the move may have little impact on soaring oil prices and didn't ease concerns that the global economy could be damaged.

The agreement by 11 oil-rich nations Thursday to keep crude production steady came despite lobbying by Venezuelan President Hugo Chavez for a production cut.

Leading oil company executives doubted the decision would prompt prices to fall.
Chavez's call for a cut in production is worth some exploration. Oil traders, encouraged by recent news that high gas prices have led to a small reduction in projected demand, especially in the US, believe that oil and gas inventories will build in the coming year, leading to a slackining in the market. Eager to nip that possibility in the bud, Mr Chavez has called for (1) a trim in production now, and (2) a $50 per barrel floor on oil prices for the future. According to Forbes, Chavez believes that an appropriate upper end on prices is "infinity."

But high oil prices make other OPEC nations very nervous. This is key. From Forbes:
While high oil prices mean big profits for oil producers in the near term, the longer-term risk is that they could cause a drop-off in economic growth and spur the development of alternative energy sources.
I didn't really understand OPEC's current quandary until I read this. In this very tight oil market, OPEC worries that very high oil prices will drive an economic incentive toward developing alternative energy sources.

Wouldn't that be awful?

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